8 Landmark Legal Rulings of 2008
TAMPA, Fla. (Blue MauMau) - Franchise attorneys David Beyer of DLA Piper in Tampa, Florida and Natalma McKnew of law firm Smith, Moore, Leatherwood in Greenville, South Carolina compiled hundreds of franchise cases and presented the year's highlights at the 2008 annual meeting of the American Bar Association's Forum on Franchising. Blue MauMau asked these two top attorneys, each a law partner with over a quarter century of franchise legal experience, to whittle down their list to eight landmark cases that will have the greatest impact on franchise owners.
David Beyer describes 2008 as having more case volume than prior years, but “less in monumental significance.” McKnew agrees. She says, “It's been a quiet week at Lake Wobegon,” alluding to the fictional town featured in the weekly radio show, Prairie Home Companion, where quiet isn't a bad thing. “There were very few pure franchise cases that will be meaningful for more than a year,” she declares. “This was sort of an ordinary, get-along year.”
Here are Beyer's and McKnew's top picks.
1. Bores v Domino's Pizza
Reversing a lower court's decision favoring franchisees, a federal court ruled that the franchisees' take on a phrase in their agreement didn't mean what they thought it meant and that it gave the franchisor Domino's the right to require products be bought only from them.
Background: Domino's specified franchisees had to buy a certain software and a computer system from Domino's. Franchise owners argued that their agreement guaranteed them the right to purchase a computer POS and customized software with the same functions elsewhere and that they could do so at a considerably cheaper price. The case relied on the contract phrase “any source” in which the lower court understood the clause one way and the upper court interpreted it another. One would think that alone would show that the phrase was ambiguous. However, the upper court ruled that the agreement, in saying Domino's franchisees could buy supplies from “any source,” in essence did not mean that a franchisee could purchase from any of several sources. Rather, ruled the court, "any" means "one, some, every, or all" without specification. Citing the American Heritage Dictionary's definition, the court overturned the lower court. The judge ruled that by Domino's requiring franchisees buy only its computer system and only from corporate, it met the definition of “any source,” since Domino's existed as a source. Since the franchisor qualifies by definition as “any” source, it would also be the only source. Huh?
Ambiguous terms in an agreement are customarily construed against the drafter (in this case Domino's). That is to say, courts do not like parties who draft ambiguous contracts, and as a rule ding the writer of such contracts by ruling against them. But this ruling was different. The upper court didn't think the phrase “any source” was ambiguous at all.
The result? Bores and other franchisees in the class action suit ended up having to pay the franchisor's attorney fees of almost half a million dollars. That sum did not include their own legal fees. Ouch!
Winner – franchisor
2. Atlanta Bread Company v Lupton-Smith
A Georgia court ruled that a franchisor's noncompete clause did not have a stated time limit or stated geography, therefore it was not enforceable.
Background: An Atlanta Bread franchise owner became involved in a competing concept, PJ's Coffee. Atlanta Bread sued the franchisee saying that it could not simultaneously represent it and another franchise brand that offered overlapping products. The court ruled that franchisors could not keep franchise owners from competing with the brand forever or ban them throughout the country from working in a business they knew.
What really shook the industry wasn't the application of this principle “ex-term,” or after a franchise has been terminated, but rather that the Georgia courts applied the need for stated noncompete limits “in-term.” In other words, while the franchisee was still conducting his business as an active franchise under the umbrella of his franchisor, he could compete with the franchise. In speaking of the clearer limitations that the court demanded in the contract, Attorney Beyer queries, “How can a franchisor limit a noncompete clause's stated time when a franchisee is an ongoing franchise?” Stunned, the International Franchise Association, a trade association and lobbyist for franchising firms, wrote a brief to the court, advising them to rule differently. It stated its concern was that the ruling “could render unenforceable the in-term restrictive covenants in the vast majority of franchise contracts for businesses operated in Georgia, including many of the most well-known and respected franchises in the world."
Winner - franchisee
3. Schlotzsky's Franchise v Sterling Purchasing & National Distribution Company
The court creatively used Section 43(a) in the Lanham Act (the U.S. trademark law) to prevent a supplier from usurping the franchisor's intellectual property and franchise rights.
Background: After franchisors and franchisees survived a financial maelstrom, a supplier – Sterling Purchasing & National Distribution Company – tried to save the system, and then attempted to push the franchisor out and become the franchising entity. The court used trademark law to claim an affiliation with the owner of that mark, Schlotzsky's, not the supplier. Attorney McKnew observes, “This case has a practical application to our current economic situation. Schlotzky's was in bankruptcy. The franchisees wanted to keep the valuable trademark, so what could they do?” The product suppliers were reluctant to continue supplying owners. Franchisees banded together, formed a franchisee organization and took control by picking a supplier to take the place of the franchisor to make sure franchisees received supplies. The bankruptcy trustee wanted to keep the brand and the value in the system. Schlotzky's Franchising went along with it to cooperate with franchise owners, but in the process it found itself in a position in which a strong Sterling Purchasing tried to push Schlotzky's out. The court ruled that Schlotzky's and not the supplier was in control of the franchise and intellectual property rights.
Winner - franchisor
4. Pinnacle Pizza Co., Inc. v Little Caesar Enterprises, Inc.
Franchisors may be grateful to franchisees for creating new products, but they don't have to reimburse them.
Background: A franchise owner invented a new product, “Hot and Ready,” and wanted to be reimbursed by the franchisor for his efforts. Pinnacle Pizza had a provision in its franchise contract that is typical of many franchise systems: namely, all system improvements belong to the franchisor whether or not they are invented at the franchisee level. The franchisor did not reimburse the franchisee nor give up the rights to the product.
Ms. McKnew comments, “The clause in the franchise agreement that sealed the franchisee's fate (at least in this case) is what I would call a 'grantback' clause. It's common in patent licenses, and basically it says if you (franchisee, in this case) come up with improvements or new related products, you agree to grant us all the rights in those improvements or products.”
Attorney Beyer says, “I might add as winners all other Little Caesars franchisees to the Pinnacle Pizza case.” That's because franchisees can continue to use the Little Caesers' “Hot and Ready” product invented by franchisee Pinnacle Pizza without additional royalties and long after the franchise is gone.
Winner – franchisor
5. Cottman Transmission v Kershner
The court reaffirmed that franchisors generally do not have a fiduciary relationship with franchise owners in connection with their franchise agreements, but when franchisors do act in a fiduciary way with their franchisees, they take on legal obligations to franchisees.
Background: Franchisees challenged Cottman on their discretion on how its ad funds were used in buying and developing advertising. Franchisees maintained that Cottman had a fiduciary duty to spend the ad fund for the benefit of the franchisees.
In a second matter, Cottman helped franchisees resell their franchises, in essence becoming a resale broker. The court ruled on the first matter that Cottman did not have a fiduciary relationship with franchisees on how it used the ad funds. However, in steering potential buyers away from the franchisees' centers to purchase Cottman's company-owned centers, it had breached a fiduciary responsibility that it had created with franchisees by acting as their resale broker.
Winner – franchisor on ad fund, franchisees on the selling of their franchises
6. Sheridan v Marathon Petroleum
Judge uses economic rationale to explain that binding a franchise to a trademark does not qualify as an illegal tie under the Sherman Act.
Background: Franchisees continue to search for a remedy for franchisor misconduct in the Sherman Antitrust Act, and tying claims have been frequently asserted in that attempt. McKnew observes, “Tying may be an antitrust violation if an entity with market power requires a purchaser to buy unwanted goods or services as a condition of getting the desired good or service.” In this case, gas station owner Sheridan, the franchisee, argued that it really just wanted the Marathon brand, and that Marathon's requirement that it had to purchase Marathon's credit card processing services violated the Sherman Act as an illegal tie.
In this case, Judge Posner rejected the franchisee's theory, saying that a trademark alone can't serve as the basis for an illegal tie. The result is consistent with other courts, but because of his strong background in Chicago School economics, Judge Posner's rationale was economic.
Winner - franchisor
7. Hall Street Associates v Mattel
In 2008 the Supreme Court extinguished any right under the Federal Arbitration Act to contractually expand appellate jurisdiction over arbitration awards.
Background: Although this was not a franchise case, nonetheless its implications to franchisor and franchisee are profound. McKnew explains that appealing an arbitration award under the Federal Arbitration Act is normally like “squeezing through the eye of a needle.” Franchisors have tried to remedy this by drafting arbitration clauses in franchise agreements where the parties agree to an expanded scope of appellate review for arbitration awards.
In Hall Street v Mattel, the U.S. Supreme Court decided that parties have no right to expand appellate review. “You don't get another shot,” says McKnew in explaining that once an arbitration panel has issued a decision, “that's pretty well the end of the story unless you can squeeze through that needle's eye.” For example, arbitration court fraud would be a reason for appellate review.
Winner – federal courts who receive a lighter case load Loser – both franchisees and franchisors who are now virtually cut off from appellate review
8. PuroSystems v Fralc
The court ruled that a franchisee could not escape its obligations to not compete with the brand by filing for bankruptcy.
Background: The franchise stopped paying royalty fees and was subsequently terminated. The dispute went to arbitration and PuroSystems was awarded damages. Arbitration said the franchisor could indeed enforce its noncompete covenant with the franchise owner. The arbitrator ruled in the franchisor's favor and extended the expiration of the clause out because the franchisee had been in competition with PuroSystems within the two-year period. Meanwhile, the franchisee moved to the next step in escaping not only its credit obligations but also its noncompete obligation by filing bankruptcy.
PuroSystems sued and sought permission from the bankruptcy court to have the two-year noncompete covenant honored. The bankruptcy court upheld the arbitration panel's decision and is currently deciding how much longer to extend the franchisee's ability to not compete.
Attorney Beyer observes, "With this distressed economic environment, we may see franchisees try to avoid their franchise obligations through bankruptcy court. But the courts stand for the proposition that such moves will not be permitted. We may see this ruling's aftereffects frequently in new court rulings of 2009."
Winner – franchisor
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Related Reading:
Case citations (for the legal eagles out there):
- Bores v. Domino's Pizza, LLC, 530 F.3d 671 (8th Cir. 2008)
- Atlanta Bread Company Int'l, Inc. v. Lupton-Smith, 663 S.E.2d 743 (Ga. Ct. App. 2008)
- Schlotzsky's Ltd. v. Sterling Purchasing & National Distribution Co., Inc., 520 F.3d 393 (5th Cir. 2008)
- Pinnacle Pizza Co., Inc. v. Little Caesar Enterprises, Inc., 2008 U.S. Dist. LEXIS 44651 (D.S.D. June 5, 2008)
- Cottman Transmission Systems, LLC v. Kershner, 536 F.Supp. 2d 543 (E.D. Pa. 2008)
- Sheridan v. Marathon Petroleum Company, 530 F.3d 590 (7th Cir. 2008)NewCal Industries, Inc. v. Ikon Office Solutions, 513 F.3d 1038 (2008)
- Hall Street Associates, LLC v. Mattel, Inc. 128 S.Ct.1396 (2008)
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